It is ancient wisdom that “you can’t beat something with nothing.” It’s also well established that it’s best to have a backup plan when what you’ve set out to do is both novel and challenging. These rules were “flung down and danced upon”1 recently in Estate of Tanenblatt.2
This is all the more surprising given the rather bland beginnings of the case. The decedent died with a 16.67 percent member interest in a limited liability company (LLC) held in a revocable trust. The LLC owned a 10-story class C building with retail and office space located in the Midtown South/Ladies Mile sector of Manhattan. The building was valued at approximately $20 million and the net asset value (NAV) of the LLC was later stipulated by both parties at $20,628,221. The taxpayer filed Form 706 attaching the property appraisal plus a valuation report from Management Planning, Inc., applying discounts of 20 percent for lack of control and 35 percent for lack of marketability, valuing the interest at approximately $1.8 million. The respondent’s notice of deficiency accepted the NAV starting point of the petitioner, but allowed discounts of only 10 percent for lack of control and 20 percent for lack of marketability, valuing the interest at approximately $2.5 million.
So far, so conventional. The stage was now set for a standard “dueling appraisers” valuation battle, fought on the well-trodden terrain of empirical data, models, and spreadsheets. These can be very exciting indeed, if you’re a valuation expert (sadly, from what I’ve been told, less so for anyone outside of the appraisal profession). And it is safe to assume that the Court’s decision might have gone either way or perhaps to another “split down the middle” decision.
But the taxpayer, in its petition for redetermination, went in a more adventurous direction – instead of standing by its prior position, and the MPI valuation, it attached a copy of a new valuation, by Dr. Laura J. Tindall, valuing the Estate’s interest at just above $1 million, in effect asking the Tax Court for a substantial refund. Ms. Tindall, moreover, was apparently not asked to testify.3 And the respondent did not accept the submission of the Tindall valuation into evidence. The issues for the Court’s determination in the matter included:
- Should the Tindall valuation be “in evidence” in the case?
- Should the subject member interest in the LLC instead be properly considered an assignee interest?
- What was the value of the subject interest, whatever its characterization?
The Tindall Valuation
The Federal Rules of Evidence, and the Court’s own rules, reflect the fact finder’s traditional role (as enforced further in recent Supreme Court decisions) as gatekeeper for the admission of expert testimony and reports. In the words of the Court, the petitioner in this case tried to “end-run” these rules by demanding the respondent stipulate to the petition and (since the petition included the Tindall valuation as an attachment) thereby to the Tindall valuation. This bizarre argument was unsurprisingly rejected by the Court. Had Dr. Tindall been available to testify, after qualifying her as an expert, her report could have been admitted as evidence. But she wasn’t.
Member or Assignee?
The failure of Dr. Tindall to appear in court – and the resulting low likelihood that the Tindall valuation would be given any weight – would suggest another strategy for petitioner: fall back on the MPI valuation! Perhaps this strategy seemed too obvious to follow? In any case, the petitioner proceeded to argue that both the MPI valuation, and the valuation of the respondent’s experts, Klaris Thomson & Schroeder, should be rejected by the Court, because they valued the wrong kind of interest.4 KTS and MPI, in their reports, referred to the interest as a member interest, which is also how it was described on the tax return. In Court, however, the petitioner wanted the interest classified as an assignee interest, even though, in the words of the Court:
Decedent was a member of the LLC when she transferred the subject interest to the trust … indicating that the decedent’s interest in the LLC was of the fullest kind; i.e., she shared in management and control and did not merely share in profits and losses … For the same reasons, the term is a convenient and accurate classification for the subject interest in the hands of the trust, which also was a member of the LLC.
Petitioner instead tried to argue that in the hypothetical transaction envisioned under the “fair market value” definition (where the interest is imagined sold to an unrelated party), the resulting owner would be an assignee, since only family members could also be members of the LLC. The Court correctly sees straight through that argument:
Petitioner, however, seeks to collapse the two steps of the valuation process – i.e., (1) identify the property to be valued and its nature and character, and (2) objectively determine its value – into a single step. Petitioner would … redefine the character of the subject interest as an assignee interest.
Having disavowed its own MPI valuation, having failed to get the Tindall valuation into evidence, and having struck out in its attempts to re-characterize the interest being valued, the estate found itself cornered, with no ammunition left. The Court accepted the KTS valuation without changes.
Discussion
At Pluris, we have the pleasure to work on some very tricky valuation issues and some of the largest and most complex of valuation cases. This case should not have been especially challenging for either party, or the Court. Mostly, it treads fairly well-worn ground, and to the extent that it is instructive it is more as an example of what not to do. Clearly, the Estate would have been better off sticking with its initial rather conventional position here. More importantly, its whimsical and “unusual, to say the least” (the Court again) arguments were poorly designed to convince a skeptical trier of fact. All in all, not a good day in court for the taxpayer.
1 With apologies to Mark Twain.
2 Estate of Diane Tanenblatt v. Commissioner, TCM 2013-263.
3 Or was asked but didn’t appear, presumably due to a fee dispute. The Court quotes from its transcripts: [In response to the Court’s questions] “petitioner’s counsel candidly responded: ‘Probably. Your honor, because right now my client’s in a fee dispute with the appraiser, so right now I cannot get the appraiser to come in and testify.’ Apparently, counsel’s time is less dear than was Dr. Tindall’s.”
4 The KTS valuation opined on a value of the subject interest of $2.3 million, or approximately $200,000 below the initial valuation of the service, pre-trial. The KTS valuation applied discounts for lack of control and marketability of 10 percent and 26 percent, respectively.